Wall Street Prep: Advanced
Accounting
How would raising capital through share issuances affect earnings per share (EPS)? -The
impact on EPS is that the share count increases, which decreases EPS. But there can be an
impact on net income, assuming the share issuances generate cash because there would be
higher interest income, which increases net income and EPS. However, most companies'
returns on excess cash are low, so this doesn't offset the negative dilutive impact on EPS from
the increased share count.
Alternatively, share issuances might affect EPS in an acquisition where stock is the form of
consideration. The amount of net income the acquired company generates will be added to the
acquirer's existing net income, which could have a net positive (accretive) or negative (dilutive)
impact on EPS.
How would a share repurchase impact earnings per share (EPS)? -The impact on EPS following
a share repurchase is a reduced share count, which increases EPS. However, there would be
an impact on net income, assuming the share repurchase was funded using excess cash. The
interest income that would have otherwise been generated on that cash is no longer available,
causing net income and EPS to decrease.
But the impact would be minor since the returns on excess cash are low, and would not offset
the positive impact the repurchase had on EPS from the reduced share count.
What is the difference between the effective and marginal tax rates? -Effective tax rate: %
corporations must by in taxes
Effective tax rate = Taxes paid / earnings before tax
Marginal tax rate: % on the last dollar of a company's taxable income.
, Why is the effective and marginal tax rate often different? -Effective and marginal tax rates differ
because the effective tax rate calculation uses pre-tax income from the accrual-based income
statement. Since there's a difference between the taxable income on the income statement and
taxable income shown on the tax filing, the tax rates will nearly always be different. Thus, the
"Tax Provision" line item on the income statement rarely matches the actual cash taxes paid to
the IRS.
Could you give specific examples of why the effective and marginal tax rates might differ? -
Under GAAP, many companies follow different accounting standards and rules for tax and
financial reporting.
i. Most companies use straight-line depreciation (i.e., equal allocation of the expenditure over
the useful life) for reporting purposes, but the IRS requires accelerated depreciation for tax
purposes - meaning, book depreciation is lower than tax depreciation for earlier periods until the
DTLs reverse.
ii. Companies that incurred substantial losses in earlier years could apply tax credits (i.e., NOL
carryforwards) to reduce the amount of taxes due in later periods.
iii. When debt or accounts receivable is determined to be uncollectible (i.e., "Bad Debt" and
"Bad AR"), this can create DTAs and tax differences. The expense can be reflected on the
income statement as a write-off but not be deducted in the tax returns.
What are deferred tax liabilities (DTLs)? -Deferred tax liabilities ("DTLs") are created when a
company recognizes a tax expense on its GAAP income statement that, because of a
temporary timing difference between GAAP and IRS accounting, is not actually paid to the IRS
that period but is expected to be paid in the future.
DTLs are often related to depreciation. Companies can use accelerated depreciation methods
for tax purposes but elect to use straight-line depreciation for GAAP reporting. This means that
for a given depreciable asset, the amount of depreciation recognized in the earlier years for tax
purposes will be greater than under GAAP.
Those temporary timing differences are recognized as DTLs. Since these differences are just
temporary - under both book and tax reporting, the same cumulative depreciation will be
recognized over the life of the asset - at a certain point into the asset 's useful life, an inflection
point will be reached where the depreciation expense for tax reporting will become lower than
for GAAP.
What are deferred tax assets (DTAs)? -Deferred tax assets ("DTAs") are created when a
company recognizes a tax expense on its GAAP income statement that, due to a temporary
timing difference between GAAP and IRS accounting rules, is lower than what must be paid to
the IRS for that period. These net operating losses ("NOLs") that a company can carry forward
against future income create DTAs.
For example, a company that reported a pre-tax loss of $10 million will not get an immediate tax
refund. Instead, it'll carry forward these losses and apply them against future profits.
However, under GAAP, the tax benefit will be recognized from a presumed future tax refund
immediately on the income statement, and this difference gets captured in DTAs. As the
Accounting
How would raising capital through share issuances affect earnings per share (EPS)? -The
impact on EPS is that the share count increases, which decreases EPS. But there can be an
impact on net income, assuming the share issuances generate cash because there would be
higher interest income, which increases net income and EPS. However, most companies'
returns on excess cash are low, so this doesn't offset the negative dilutive impact on EPS from
the increased share count.
Alternatively, share issuances might affect EPS in an acquisition where stock is the form of
consideration. The amount of net income the acquired company generates will be added to the
acquirer's existing net income, which could have a net positive (accretive) or negative (dilutive)
impact on EPS.
How would a share repurchase impact earnings per share (EPS)? -The impact on EPS following
a share repurchase is a reduced share count, which increases EPS. However, there would be
an impact on net income, assuming the share repurchase was funded using excess cash. The
interest income that would have otherwise been generated on that cash is no longer available,
causing net income and EPS to decrease.
But the impact would be minor since the returns on excess cash are low, and would not offset
the positive impact the repurchase had on EPS from the reduced share count.
What is the difference between the effective and marginal tax rates? -Effective tax rate: %
corporations must by in taxes
Effective tax rate = Taxes paid / earnings before tax
Marginal tax rate: % on the last dollar of a company's taxable income.
, Why is the effective and marginal tax rate often different? -Effective and marginal tax rates differ
because the effective tax rate calculation uses pre-tax income from the accrual-based income
statement. Since there's a difference between the taxable income on the income statement and
taxable income shown on the tax filing, the tax rates will nearly always be different. Thus, the
"Tax Provision" line item on the income statement rarely matches the actual cash taxes paid to
the IRS.
Could you give specific examples of why the effective and marginal tax rates might differ? -
Under GAAP, many companies follow different accounting standards and rules for tax and
financial reporting.
i. Most companies use straight-line depreciation (i.e., equal allocation of the expenditure over
the useful life) for reporting purposes, but the IRS requires accelerated depreciation for tax
purposes - meaning, book depreciation is lower than tax depreciation for earlier periods until the
DTLs reverse.
ii. Companies that incurred substantial losses in earlier years could apply tax credits (i.e., NOL
carryforwards) to reduce the amount of taxes due in later periods.
iii. When debt or accounts receivable is determined to be uncollectible (i.e., "Bad Debt" and
"Bad AR"), this can create DTAs and tax differences. The expense can be reflected on the
income statement as a write-off but not be deducted in the tax returns.
What are deferred tax liabilities (DTLs)? -Deferred tax liabilities ("DTLs") are created when a
company recognizes a tax expense on its GAAP income statement that, because of a
temporary timing difference between GAAP and IRS accounting, is not actually paid to the IRS
that period but is expected to be paid in the future.
DTLs are often related to depreciation. Companies can use accelerated depreciation methods
for tax purposes but elect to use straight-line depreciation for GAAP reporting. This means that
for a given depreciable asset, the amount of depreciation recognized in the earlier years for tax
purposes will be greater than under GAAP.
Those temporary timing differences are recognized as DTLs. Since these differences are just
temporary - under both book and tax reporting, the same cumulative depreciation will be
recognized over the life of the asset - at a certain point into the asset 's useful life, an inflection
point will be reached where the depreciation expense for tax reporting will become lower than
for GAAP.
What are deferred tax assets (DTAs)? -Deferred tax assets ("DTAs") are created when a
company recognizes a tax expense on its GAAP income statement that, due to a temporary
timing difference between GAAP and IRS accounting rules, is lower than what must be paid to
the IRS for that period. These net operating losses ("NOLs") that a company can carry forward
against future income create DTAs.
For example, a company that reported a pre-tax loss of $10 million will not get an immediate tax
refund. Instead, it'll carry forward these losses and apply them against future profits.
However, under GAAP, the tax benefit will be recognized from a presumed future tax refund
immediately on the income statement, and this difference gets captured in DTAs. As the
